Second in a series of articles on “How to Survive an IRS Audit of your Aircraft”

There are many valid business reasons to separate aircraft ownership from the operating companies it serves. These often include liability protection, ownership differences, and managerial issues to name a few. Although it is often beneficial to segregate ownership for non-tax reasons, it is important to avoid inadvertently causing the aircraft entity to be treated on a “stand-alone” basis for passive activity income tax purposes.

In a welcome display of good governance, Congress this year has largely broken its recent routine of allowing important tax incentives to expire with the start of each new year, only to retroactively reinstate those provisions as year-end approaches—leaving taxpayers during the interim on tenterhooks, guessing what tax laws they will be subject to.

When a financed aircraft is owned in a special-purpose company, which lacks assets other than the aircraft, it is typical and understandable for the financing bank to insist that, in order to extend this special-purpose company a loan to purchase the aircraft, that loan must be guarantied by another, more solvent person or company. In fact, banks will often seek multiple, overlapping guaranties—for example, from both spouses a couple, or from an individual and another company owned by that individual.

A notable milestone in the cat-and-mouse game of individuals seeking to minimize tax burden and Congress making new laws to end potential shelter activity is the Passive Activity Rule, which was originally enacted as part of the Tax Reform Act of 1986, and which recent developments have brought prominently to the minds of tax advisors. In particular, an important one-time opportunity to avoid being trapped under this rule arises from new IRS regulations issued in November 2013 due to the new net-investment income tax passed as part of the 2010 Patient Protection and Affordable Care Act (a/k/a “Obamacare”).

Businesses throughout the country routinely make use of general aviation aircraft to provide travel and communication efficiencies that provide them with an important competitive advantage. As part of a general Congressional approach to encourage business investments, the Tax Code allows a rapid depreciation schedule for aircraft that allows owners to fully write-off purchase/acquisition costs over a period of time (usually five year) that is far less than the economic life of an aircraft.

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